AG 38: Still In-Force Reserve Concerns and New Business Process Issues

Work being done by the NAIC on resolving the thorny Actuarial Guideline 38 for universal life products with secondary guarantees (USLG) is focused now on reserving methodologies for business written before or after Jan 1, 2013.

However, some parties are still concerned about capturing the right reserve levels, and those that may have to cough up more reserves for prior years are worried about the impact on their financial statements.

One person wondered aloud if the NAIC were creating some new regulatory body of actuaries who would make the rounds from company to company, state to state, and either approve or disapprove their reserving methodologies, an idea the NAIC tele-conference leadership quickly tried to quash.

The Joint Working Group emphasis is now on using a stochastic reserve methodology for in-force business if it is greater than the reserving methodology currently used by the company.

New York’s Rob Easton, Executive Deputy Superintendent, Insurance Division, of the Department of Financial Services, weighed in, questioning the modern, principles-based reserving (PBR) model’s stochastic approach as opposed to a “one interest rate scenario” that the Life Actuarial Task Force (LATF) had floated as its preference even earlier today.

Rector, a long-time and respected insurance regulatory consultant, Neil Rector of Rector + Associates Inc., Columbus, Ohio, was hired to hammer out some of the fine points after canvassing the industry for input and information on the issue. He responded that there was concern about the level interest rate scenario and that there is a need to make sure companies’ existing assets are taken into account. In most scenarios, he explained, those with assets above or below the line aren’t reflected in that one-interest-rate economic approach, he said.

The proposed NAIC guideline, subject to further exposure and review, states that a company can report in its financial statements the greater of the PBR stochastic reserve or the company’s current reserving methodology.

Stochastic reserve modeling, as opposed to a deterministic approach, under PBR refers to generating a set of economic scenarios and using those economic scenarios to project insurance company assets and liabilities as of a valuation date using many assumptions about premium patterns, policy terminations including death rates, and so forth, all derived according to methods specified in the NAIC’s Standard Valuation Manual currently being worked on by the NAIC.

The AG 38 matter was taken from LATF,where state actuaries from new York and other states first raised concern about USLG under-reserving. It was handed off to a new high-level committee of regulators to resolve the issues. The new group, the Joint Working Group led by Texas Insurance Commissioner Eleanor Kitzman, has been meeting with regulators and industry on the issue since at least January on the issue, and guiding the process. The Joint Working Group was formed in the wake of the NAIC national fall meeting. Kitzman made it clear early on, after listening to industry concerns that of the “many things to be worked out but a level playing field is at the top of the list.” The issue was a hot-button actuarial reserving concern centered around universal life products with secondary guarantees, and the way some companies may be under-reserving for them.

Most interested parties supported the framework, which represents a bifurcated approach to in-force business and prospective business. The goal is consensus on all methodology calculation matters, for possible adoption at the NAIC summer national meeting next month in Atlanta.

For prospective business -- written on Jan. 1, 2013 forward -- as reviewed by Rector on the call, there is a proposed blended approach to reserving, with safe harbors, as well as a fall-back “greatest deficiency” reserve methodology.

Some favor two safe harbors, while others favor three, but under the blended approach, those products that don't fit into a safe harbor would be reserved using the greatest deficiency reserve approach. For all ULSG policies, the company would then go through a calculation method -- what would lead to the largest deficiency conserve and that would be the one used for the company.

There is also a "trigger" test that could move products from a safe harbor approach to using the greatest deficiency reserve approach and also an analysis that must be done by the company to limit the possibility of inappropriately manipulating the reserve methodology, as one actuary explained.

One state actuary and LATF member, Mark Birdsall of Kansas Insurance Department, suggested that without using a safe harbor approach new policies issues of plain vanilla products would have different, possibly higher reserves than under the current AG 38.

The American Council of Life Insurers (ACLI) actuary on the call, Paul Graham, expressed a desire for any increased reserves for in-force business to be added to future financial statements, and not to ones already filed.

Retroactive application could apparently subject insurers’ to more taxes for previous filing years.

Asset adequacy tests of in-force business that could lead to some companies increasing reserves and additional reserves set up pursuant to that analysis are generally not tax deductible. Treasury is said to be looking into the issue, along with the Internal Revenues Service.

Graham, among other concerns, also voiced the need for an appeals process for insurers subject to the proposed panel of actuaries who check up on companies’ reserving work -- so companies could dispute the panel’s findings, if it came to that.

One state regulator on the call was concerned with another facet of this panel -- he raised the specter of a new regulatory body created by the NAIC with the creation of the review panel, comprised of a few designated actuaries who go around the country and check companies in-force USLG business to make sure they have done their reserving properly. Is there a List of consultants? A review team of actuaries -- are they a new regulatory body, he asked.

Rector assured him that the initial work would be done by the companies and said it was just a “peer review” or a “reasonableness review” conducted by the same two or three people looking at the numbers instead of 25 people, “so there is not a significant variation from company to company,” and “to make sure all companies are reserving in the same fashion.”

The state regulator also expressed concerns about the state process for procurement for services under formal RFPs, and Rector said the language would be modified.

Insurers had called for uniformity, modern reserving methods,and asset adequacy testing for in-force business, and said they couldn’t work with the LATF statement on AG 38 adopted by LATF at the NAIC Fall conference.

The LATF statement held that the correct application of the actuarial guideline for these product designs - and all other product designs subject to AG 38 -- “is to derive the ‘minimum gross premiums’ that represent the lowest schedule of premiums a policyholder could pay to satisfy the secondary guarantee ... When a policy contains more than one secondary guarantee, Model 830 requires reserves to be calculated using the secondary guarantee that produces the greatest reserves ignoring all other secondary guarantees.”

“LATF believes the requirements are clear and no changes or clarifications are needed to these requirements,” the statement says.